×

This chart shows that the market is approaching 'euphoric territory'

By one measure, investors are more bullish than they've been in three years, and market sentiment is approaching "euphoric territory," according to a new report from Bank of America Merrill Lynch.

The BofAML Bull & Bear Indicator is now at 7, the highest level since July 2014. The indicator, on a scale of one to 10, is derived from six measurements of sentiment: hedge fund positioning, credit market technicals, equity market breadth, equity flows, bond flows and long-only fund positioning. Currently, the first three areas have reached what BofAML analysts deem "very bullish" levels.

As a result, the gauge's current level of 7 is closing in on a "sell signal," a team led by BofAML chief investment strategist Michael Hartnett wrote in a recent report while advising clients to "stay long risk assets until sentiment reaches euphoric territory of 8.0."

On the other end of the spectrum, the indicator ticked toward "extreme bearish" levels during the market's lows of February 2016. In hindsight, that was obviously a great time to buy stocks.

This gauge's current level, however, isn't a substantial warning sign to Erin Gibbs, equity chief investment officer at S&P Global. In fact, based on the indicator's past readings in conjunction with the market's moves during these bullish sentiment levels, if investors were to sell their holdings now, they could miss out.

"The indicator has reached 7 and turned back down three times in [its] history so it's not a total assumption that we'll hit the euphoric 8 level. If investors pull the trigger early, at the 7 level, they'd typically miss about 5.5% positive return 12 months after the indicator hit 7," Gibbs wrote to CNBC on Friday. "Even if we are in the 60% change of it going to 8, only a little more the 1/3 of the time it hits 8 you see a significant decline."

Meanwhile, the market only saw substantial pullbacks about four of the 11 times the Bull & Bear indicator reached a "sell" reading of 8, Gibbs wrote.

She added that from a fundamental perspective, the positive earnings numbers she expects to see could give stocks a new reason to rally.

Videos

Trades to Watch

Trader Bios

About

Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Brian Sullivan

Brian Sullivan is co-anchor of CNBC's "Power Lunch" (M-F,1PM-3PM ET), one of the network's longest running programs, as well as the host of the daily investing program "Trading Nation." He is also a frequent guest on MSNBC's "Morning Joe" and other NBC properties.

Read more

Connect